Diversification

May 29, 2018

In my last blog post, I mentioned the importance of diversification. But what does it mean to be well-diversified? Is it simply enough to have both stocks and bonds in your portfolio?

Many people realize that you should not “put all your eggs in one basket.” However, some people don’t know what the basket should be, and many others don’t know which kind of eggs. I’m here to help break it down.

nest eggs in basket

Let’s first talk about the “basket.” This means, the type of investment vehicle in which you put your, ahem, “eggs.” This could be a 401(k), 403(b), IRA, Roth IRA, taxable account, or even a savings account. I’m not going to get into these differences in this post but when we’re talking about diversifying, we are usually talking about where you are holding your money/investments. You may have retirement accounts, checking/savings accounts, annuities, or even a plain old retail brokerage account. However, you may consider other assets as part of your whole “basket,” such as your house or any other real estate you might own, including rental properties, or even things like a coin collection or valuable cars. There is a famous episode of Sex and the City where Sarah Jessica Parker’s character, Carrie, is looking at possibly buying her apartment which is going condo, and she doesn’t really have any savings, because all her investments, are in very expensive designer shoes. So, if all your investments are in your closet, perhaps you should look at a different basket.

Next, let’s discuss the “eggs.” This could mean virtually anything, but in this context, I am mainly referring to what’s in your investment/savings accounts. There are many ways to diversify, but commonly this is referring to investing in a variety of different assets and asset classes, so that you reduce risk and volatility. This is not a fool-proof way to avoid your portfolio going up and down. As in my last blog post, volatility is a normal occurrence of the market and you are never going to be able to completely avoid it. However, you can take steps to try and reduce the bumpy ride. Just like you wear a seat belt to try and make your car ride safer, you can try to diversify to make your portfolio safer.

You will typically hear talk about stocks and bonds. These may also be referred to as equities and fixed income. These two types of investments often act differently; when stocks go up, bonds may go down, and vice versa. The idea is that you don’t want your whole portfolio to go down at the same time, or at least not all in the same way. For example, let’s say that I put all my money in one single stock. I hope I pick a good one, and maybe I think I have, since the stock has been going up for the last year or two. However, in my fictional example, let’s say it comes out that the stock company I invested in, has been lying about their earnings and on their financial statements, just like Enron, circa 2001. And what happens to the stock price? It tanks, big time. Since I put all my money in that one stock, all my money has also tanked, and with it, my hopes and dreams.

It is not enough to say you are diversified even if you have different stocks. Many times, people think they are diversified because they have chosen a mutual fund that does invest in several different stocks. However, if that mutual fund invests in all one type of asset class, such as United States large-cap stocks, then when those stocks as a whole are doing poorly, so will the mutual fund price and along with it, your investment. Sometimes we find that people have chosen a stock fund, that is almost 100% equities, and then they wonder why their account dipped so much when the markets were down in 2008-2009.

So, then, by adding both stocks/equities and bonds/fixed income to your investments, you become at least partially diversified because those are two very different types of asset classes and act differently according to the markets.

In the interest of keeping this post somewhat short, I will save the different breakdowns within each class for the next blog. Stay tuned!

The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Jill Carr and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.

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